Question 1

According to the trade-off theory, the capital structure is a trade-off between:

Accepted Answer

A) tangible and intangible asset risk. 
B) high and low target debt ratios. 
C) tax savings and financial distress costs. 
D) tax shields and equity financing. 
A) tangible and intangible asset risk. 
B) high and low target debt ratios. 
C) tax savings and financial distress costs. 
D) tax shields and equity financing.

Question 2

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?(Use values in dollar.)

Accepted Answer

A) $245,000 
B) $700,000 
C) $3,500,000 
D) $10,000,000 
A) $245,000 
B) $700,000 
C) $3,500,000 
D) $10,000,000

Question 3

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Accepted Answer

A) .50 
B) .75 
C) 1.00 
D) 1.50 
A) .50 
B) .75 
C) 1.00 
D) 1.50

Question 4

Debt usage will have an effect on:

Accepted Answer

A) business risk. 
B) financial risk. 
C) operating risk. 
D) asset risk. 
A) business risk. 
B) financial risk. 
C) operating risk. 
D) asset risk.

Question 5

Which of the following is an example of restructuring the firm?

Accepted Answer

A) dividends are increased from $1 to $2 per share. 
B) a new investment increases the firm's business risk. 
C) new equity is issued and the proceeds repay debt. 
D) a new board of directors is elected to the firm. 
A) dividends are increased from $1 to $2 per share. 
B) a new investment increases the firm's business risk. 
C) new equity is issued and the proceeds repay debt. 
D) a new board of directors is elected to the firm.

Question 6

A decrease in the possible range of percentage stock returns can be achieved by:

Accepted Answer

A) a decrease in the firm's financial leverage. 
B) an increase in the firm's asset risk. 
C) an increase in the firm's business risk. 
D) a decrease in the firm's debt beta. 
A) a decrease in the firm's financial leverage. 
B) an increase in the firm's asset risk. 
C) an increase in the firm's business risk. 
D) a decrease in the firm's debt beta.

Question 7

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Accepted Answer

Managers/owners may not have the proper

Question 8

Which of the following statements is true regarding the trade-off theory:

Accepted Answer

A) target debt ratios are similar among firms in the same industry. 
B) riskier firms tend to rely mostly on debt financing. 
C) riskier firms should have high target debt ratios. 
D) less risky firms ought to have a greater amount of debt financing. 
A) target debt ratios are similar among firms in the same industry. 
B) riskier firms tend to rely mostly on debt financing. 
C) riskier firms should have high target debt ratios. 
D) less risky firms ought to have a greater amount of debt financing.

Question 9

What is the goal of the capital structure decision? What is the financial manager trying to do?

Accepted Answer

The goal is to maximize the overall mark

Question 10

Which of the following statements is false regarding MM's proposition I:

Accepted Answer

A) firm value is unaffected by its capital structure. 
B) it is also called the debt irrelevance proposition. 
C) shareholders should care about the firm's debt policy. 
D) after restructuring, the firm's value should be the same as it was prior to restructuring. 
A) firm value is unaffected by its capital structure. 
B) it is also called the debt irrelevance proposition. 
C) shareholders should care about the firm's debt policy. 
D) after restructuring, the firm's value should be the same as it was prior to restructuring.

Question 11

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value of all-equity financed _____ the PV of the tax shield _____ the PV costs of financial distress.

Accepted Answer

A) plus; plus 
B) minus; plus 
C) plus; minus 
D) minus; minus 
A) plus; plus 
B) minus; plus 
C) plus; minus 
D) minus; minus

Question 12

Although the value of an additional interest tax shield may be positive, firms may restrict borrowing if:

Accepted Answer

A) the returns on the project are too high. 
B) their asset base is largely intangible. 
C) their asset beta is zero. 
D) the borrowing increases their WACC. 
A) the returns on the project are too high. 
B) their asset base is largely intangible. 
C) their asset beta is zero. 
D) the borrowing increases their WACC.

Question 13

The pecking-order theory of capital structure suggests the following order of financing:

Accepted Answer

A) internal financing, debt issue, equity issue. 
B) internal financing, equity issue, debt issue. 
C) debt issue, equity issue, internal financing. 
D) equity issue, internal financing, debt issue. 
A) internal financing, debt issue, equity issue. 
B) internal financing, equity issue, debt issue. 
C) debt issue, equity issue, internal financing. 
D) equity issue, internal financing, debt issue.

Question 14

MM's proposition II states that the:

Accepted Answer

A) expected return on equity increases as financial leverage increases. 
B) expected return on assets decreases as expected return on debt decreases. 
C) firm's capital structure is irrelevant to value determination. 
D) greater the proportion of equity, the higher the expected return on debt. 
A) expected return on equity increases as financial leverage increases. 
B) expected return on assets decreases as expected return on debt decreases. 
C) firm's capital structure is irrelevant to value determination. 
D) greater the proportion of equity, the higher the expected return on debt.

Question 15

What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?

Accepted Answer

A) 5.25% 
B) 9.75% 
C) 12.17% 
D) 20.25% 
A) 5.25% 
B) 9.75% 
C) 12.17% 
D) 20.25%

Question 16

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS is reduced by half, to $1? Ignore taxes.

Accepted Answer

A) operating income drops to $3.5 million. 
B) operating income drops to $3.0 million. 
C) operating income drops to $2.5 million. 
D) operating income drops to $2.0 million. 
A) operating income drops to $3.5 million. 
B) operating income drops to $3.0 million. 
C) operating income drops to $2.5 million. 
D) operating income drops to $2.0 million.

Question 17

A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount, i.e., $5,000,000.The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes, this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 50% and the number of shares in circulation is cut by 50% (assuming that the share price remains unchanged with this change in capital structure)?(Use values in dollar.)

Accepted Answer

A) EPS decrease to $10.00 
B) EPS decrease to $11.67 
C) EPS increase to $15.00 
D) EPS increase to $22.50 
A) EPS decrease to $10.00 
B) EPS decrease to $11.67 
C) EPS increase to $15.00 
D) EPS increase to $22.50

Question 18

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

Accepted Answer

Under MM Proposition II, the expected re

Question 19

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 30% of assets?

Accepted Answer

A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67% 
A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67%

Exam 16: Debt Policy

According to the trade-off theory, the capital structure is a trade-off between:

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?(Use values in dollar.)

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Debt usage will have an effect on:

Which of the following is an example of restructuring the firm?

A decrease in the possible range of percentage stock returns can be achieved by:

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Which of the following statements is true regarding the trade-off theory:

What is the goal of the capital structure decision? What is the financial manager trying to do?

Which of the following statements is false regarding MM's proposition I:

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value of all-equity financed _____ the PV of the tax shield _____ the PV costs of financial distress.

Although the value of an additional interest tax shield may be positive, firms may restrict borrowing if:

The pecking-order theory of capital structure suggests the following order of financing:

MM's proposition II states that the:

What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS is reduced by half, to $1? Ignore taxes.

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 30% of assets?

Goals and Governance of the Firm

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing and Governance

Venture Capital, Ipos, and Seasoned Offerings

Leasing

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Cash and Inventory Management

Credit Management and Collection

Mergers, Acquisitions, and Corporate Control

International Financial Management

Options

Risk Management

Filters

When corporate taxes and the cost of financial distress are taken into consideration, the market value of a firm equals the value of all-equity financed _ the PV of the tax shield _ the PV costs of financial distress.